Treasury has released for exposure draft legislation in relation to some significant proposed changes to Australia’s thin capitalisation provisions. These provisions can place a limit on the ‘debt deductions’ (e.g., interest deductions) that can be claimed in Australia by foreign controlled resident entities and resident entities with overseas operations.
The proposed amendments are comprehensive and seek to ensure that the Australian system is aligned with the OECD’s recommendations on base erosion and profit shifting (BEPS).
One of the key points to note here is that the new rules are intended to come into effect from 1 July 2023, leaving limited time for business groups to analyse the practical application of the changes and for the ATO to provide detailed guidance on the updated rules if they end up passing through Parliament. It is yet to be seen whether a transitional approach will be implemented.
It will be essential for affected taxpayers to carefully consider the proposed changes and the interaction between these new rules and other aspects of the tax law. The two key changes to the rules involve:
- Removing the current classifications of ‘inward investor’ and ‘outward investor’ with a single category relevant for all entities other than financial entities and ADI’s (i.e., banks). This should simplify the early stages of working through the rules.
- A wholesale replacement of the applicable debt tests. The current methods of establishing whether debt deductions are allowable (the safe harbour debt test, worldwide gearing ratio test, and arm’s length debt test) will be replaced by a fixed ratio test, a group ratio test, and an external third-party debt test.
The new tests involve a change from an asset-based approach to using earnings-based tests. However, it appears that some existing exclusions from the rules, such as the $2m de minimis threshold, will be retained.
The exposure draft legislation also contains a previously unannounced measure that removes deductions previously available under section 25-90 and section 230-15(3) ITAA 1997 for interest expenses incurred in deriving certain foreign dividends that are non-assessable non-exempt income under section 768-5.
